Jim Cramer disagrees with Warren Buffett on this classic piece of investing advice—here's why

The article highlights the contrasting investment philosophies of Warren Buffett and Jim Cramer regarding passive versus active management. Buffett advocates for S&P 500 index funds for most investors, citing S&P Global data that only 12% of actively managed large-cap U.S. funds outperformed the index over a 15-year period. Conversely, Jim Cramer proposes a hybrid strategy, recommending index funds for approximately half a portfolio while encouraging individual stock picking for the remainder to achieve superior returns, arguing against settling for average market performance and citing examples of significant individual stock outperformance.

Analysis

Warren Buffett has long recommended investing in index funds. For everyday investors, owning low-cost, passive funds provides access to a broad swath of the market, which helps mitigate the risk that a slide in one or even a few stocks torpedoes your portfolio’s performance. Plus, you’ll likely come out ahead of a lot of professional investors over the long run, the Berkshire Hathaway chairman says. “In my view, for most people, the best thing to do is to own the S&P 500 index fund,” he said at the 2021 annual meeting of Berkshire Hathaway shareholders. Indeed, over the 15 years that ended June 30, just 12% of actively managed funds that track large-company U.S. stocks outperformed the S&P 500, according to S&P Global. Jim Cramer agrees with Buffett’s philosophy — to an extent. The host of CNBC’s Mad Money says broad market index funds should make up about half of your portfolio, with most of the rest disbursed across a handful of individual stocks. The central idea around Cramer’s new book, “How to Make Money in Any Market,” is simple: In addition to owning a diversified portfolio, anyone can also be savvy enough to research and own winning stocks. “Let’s say you did my method, my program, where you were half index funds, and let’s say you picked a good stock. How about Berkshire Hathaway?” Cramer tells CNBC Make It. “Had you bought Berkshire Hathaway, you would have made a fortune.” Since the start of 1982, stocks in the S&P 500 have returned a cumulative 11,916%. Berkshire shares have grown by 133,775%. Why Cramer differs from Buffett Buffett’s advice applies to what he calls “know-nothing investors.” That’s because Buffett, a great stock picker, knows how much work goes into building a market-beating portfolio. “You do not want to ever get the impression that you can pick stocks,” he told CNBC’s On the Money in 2017. Rather, he said, “The trick is not to pick the right company, the trick is to essentially buy all the big companies through the S&P 500 and to do it consistently and to do it in a very, very low-cost way.” But Cramer argues that anyone can pick great stocks and shouldn’t settle for index returns. “I hate average, even as I accept it as a necessary evil in a diversified portfolio,” he writes in his book. “Are you proud of being average in any other walk of life? Would you have bought a book called Making Money the Average Way by Mediocre Joe? The S&P is average.” To beat the average, Cramer says, you’ll have to pick a handful of stocks that will deliver prodigious long-term growth — a task that’s easier said than done. But to find an example of investors who beat the odds, Buffett needs to look no further than the arena full Berkshire Hathaway shareholders who attend his annual meetings, Cramer says. “Since 1982, I’ve been recommending that stock. How do you think I’ve done for people versus the index fund?” Cramer says. “I crushed it.” Upgrade to an annual CNBC Investing Club membership today and claim your free, signed copy of Jim Cramer’s new book, “How to Make Money in Any Market.” (See terms and conditions for complete offer details. This promotion is available only while supplies last. See the full disclaimer here for important limitations and exclusions.) Plus, sign up for CNBC Make It’s newsletter to get tips and tricks for success at work, with money and in life, and request to join our exclusive community on LinkedIn to connect with experts and peers. The article presents a foundational debate in investment strategy, contrasting Warren Buffett's advocacy for passive indexing with Jim Cramer's hybrid active-passive approach. Buffett's position is empirically supported by S&P Global data, which shows that a mere 12% of actively managed large-cap U.S. stock funds outperformed the S&P 500 over the 15-year period ending June 30. This data reinforces his long-held view that most investors, whom he terms 'know-nothing investors,' are best served by consistently buying low-cost S&P 500 index funds to mitigate risk and capture market returns. Conversely, Jim Cramer argues against settling for 'average' market performance, proposing a portfolio structure of approximately 50% in index funds with the remainder dedicated to a handful of individually researched stocks. To illustrate the potential alpha generation of this active component, he cites the significant outperformance of Berkshire Hathaway, which returned 133,775% since 1982 compared to the S&P 500's 11,916%. The core of the disagreement lies in the perceived ability of the average person to successfully pick stocks, a task Buffett considers exceedingly difficult, while Cramer presents it as an achievable goal for the diligent individual.

Key Decisions for Investors

• Given that data shows only 12% of active managers beat the S&P 500 over a 15-year horizon, investors should critically evaluate the fees and performance of their actively managed funds and consider anchoring their portfolio in low-cost, broad-market index funds.
• For investors with higher risk tolerance and the capacity for in-depth research, adopting a 'core-satellite' strategy similar to Cramer's could be considered, allocating a smaller, actively managed portion of the portfolio to high-conviction individual stocks with the potential for outsized returns.
• Investors must perform a realistic self-assessment of their time, expertise, and willingness to conduct due diligence before pursuing an active stock-picking strategy, as the evidence presented suggests that successful outperformance is an exception rather than the norm.